Rising Bond Yields—This Is Just the Start

Brighter economic prospects, diminishing fears about a U.S. fiscal crisis and the idea that the beginning of the end is in sight for a period of ultra-easy monetary policy have sent government bond yields racing higher at the start of the year.

Indeed, faced with this backdrop, it appears that bond yields, low for so long, finally look like they are heading higher, analysts say.

A sell-off in bonds has pushed yields on 10-year Treasurys up more than 15 basis points since the start of January to about 1.87 percent. They are about half a percent above record lows hit last July when concerns about the euro zone debt crisis sent investors scurrying into safe-haven debt.

"We may see a fairly significant move in the 10-year yield and I think it could go up to as high as 3 percent in the next 12-18 months," Mike Crofton, president and CEO at Philadelphia Trust Company told CNBC, adding that money is now starting to move out of bonds and into stocks.

Yields on benchmark Treasurys have fallen some 200 basis points in the past five years as investors overlooked U.S. fiscal woes and hefty debt issuance to snap up safe-haven bonds in the face of a weak economic growth and volatile stock markets.

Even as many analysts predicted a bursting of the bond market "bubble" last year, yields continued to decline amid risk aversion.

But the sell-off seen in the early days of 2013 may be a taste of more to come, analysts say.

"Treasury yields are something that I am paying more attention to, with yields on 10-year Treasurys really close to the psychologically important 2-percent mark," David Rodriguez, Quantitative Strategist at Daily FX in New York told CNBC Asia's "Squawk Box."

"And with all the mess going on in Washington, there is a real risk that bond investors are losing patience with Treasurys given the fact that U.S. has massive deficits," he said.

The United States must do more than the recently passed "fiscal cliff" measures if the country is to rescue its triple-A debt rating from its current negative outlook, rating agency Moody's Investors Service warned last week.

Who Needs a Safe Haven?

In a sign that risk appetite, to the detriment of the safe-bond market, is coming back in force, the VIX index, a popular gauge of fear in the equity markets plunged almost 40 percent last week.

Kathy Lien, managing director at BK Asset Management in New York, says that the fall in the VIX index and spike in bond yields are the two most interesting developments in financial markets at the start of the new year.

"The increase in yields and decline in Treasury prices reflects worries that the Federal Reserve could end asset purchases in 2013. The "fiscal cliff" deal also removed some risk in the market, encouraging investors to dive back into riskier assets," she said in a research note.

Markets are starting to ponder whether the Fed will end its bond purchase program before the end of the year, after minutes from the Fed's December meeting released last week showed growing unease on continuing the buybacks.

But with the economic recovery still in its early stages, unemployment still high and inflation contained, financial markets are not expecting the Fed to tighten monetary policy anytime soon.

And that means a collapse in the bond market is unlikely, analyst said.

A Collapse in the US Treasury Market?

Edward Perks, Portfolio Manager, Franklin Income Fund discusses the risks of having exposure to fixed income.

"It is certainly possible, but it is not our call," said Edward Perks, portfolio manager at Franklin Income Fund in California, when asked on "Squawk Box" about the potential for a collapse in the bond market this year.

Data over recent months has painted a brighter picture of the U.S. economy, with the latest jobs numbers showing 155,000 new jobs were added in December, continuing a trend of slow improvement.

"The main reason for rising yields is that Treasurys' role as a safe-haven asset is declining and the economy is moving inexorably towards the first rate hike," David Keeble, global head of interest rate strategy at Credit Agricole said in a note.

"Not only do we believe that the low point in Treasury yields has been hit but also that implied and actual volatilities will begin to ascend," he added.